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    Listening, connected, committed to… Annual Report 2007 Xerox Annual Report 2007 2

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    Accelerating the adoption of color. Driving The New Business of Printing.® Expanding participation in small and medium businesses. Leading with services. These are the priorities we focus on every day. And as important as they are, they are no more than a means to our ultimate priority: you. In business today, especially our business, making it personal makes a difference in the value we bring to you. For us that means creating a great experience for you, our customer… delivering greater returns for you, our shareholder… and acting responsibly as a corporate citizen for you, our stakeholders and employees who expect nothing less. We listen. We’re connected. We’re committed. To you.

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    1 28 77 Financial overview Board of directors Financial statements 2 30 Inside back cover Letter to shareholders Our business Corporate information and officers 12 52 Customer features Management’s Discussion and Analysis of Results of Operations and Financial Condition Financial overview (in millions, except EPS) 2007 2006 Total revenue $ 17,228 $ 15,895 Equipment sales 4,753 4,457 Post sale, finance income and other revenue 12,475 11,438 Net income 1,135 1,210 Adjusted net income* 1,135 1,047 Diluted earnings per share 1.19 1.22 Adjusted earnings per share* 1.19 1.05 Net cash provided by operating activities 1,871 1,617 * See Page 11 for the reconciliation of the difference between this financial measure that is not in compliance with Generally Accepted Accounting Principles (GAAP) and the most directly comparable financial measure calculated in accordance with GAAP. Xerox Annual Report 2007 1

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    Fellow shareholders: I am pleased to report that 2007 was another year of steady and solid progress – a year in which we continued to strengthen the company financially, invest in growth, and win in the marketplace. Our results included: ‡ Net income of $1.1 billion. ‡ Earnings per share of $1.19, which compares to 2006 earnings per share of $1.22. On an adjusted basis, our earnings per share grew 13 percent in 2007*. ‡ Operating cash flow of $1.9 billion. ‡ Total revenue of $17.2 billion, an increase of $1.3 billion or 8 percent. Excluding the benefit of our acquisition of Global Imaging Systems, which we purchased in May last year, revenue was up 4 percent in 2007*. ‡ Investments in strategic acquisitions totaling $1.6 billion. ‡ And disciplined cost management that kept our gross margins and selling, administrative and general costs right in line with our business model. At the same time, we continued to take steps to build shareholder value. All the credit rating agencies rank us as investment grade. We reinstated a dividend. We repurchased $631 million in Xerox stock, bringing the total repurchased since 2005 to $2.1 billion. And, as we entered 2008, our Board of Directors authorized the repurchase of an additional $1 billion of Xerox stock. We feel good about the state of our business. And, we know that consistently delivering double-digit earnings per share growth and strong operating cash flow make for the best long-term investment. It’s a value proposition we’re strengthening every day. * See Page 11 for the reconciliation of the difference between this financial measure that is not in compliance with Generally Accepted Accounting Principles (GAAP) and the most directly comparable financial measure calculated in accordance with GAAP. 2

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    The numbers, as they say, speak for themselves but they don’t tell the entire story. Turnarounds are easy to track and to talk about; transformations evolve more slowly and are harder to define. Over the past several years – step by step and brick by brick – we have built a new Xerox. I believe we are at an inflection point. We have evolved into a services-led technology company that is known for innovation and customer focus. We help manage the massive flow of information and communication in businesses today. We’re a content management provider and a trusted partner that can help our customers make the most of their IT infrastructure and bridge the paper and digital worlds. The Xerox once known for copiers, printers and paper has greatly expanded its footprint. New technology and services offerings are generating billions of dollars in recurring revenue for us. We’ve made some critical strategic bets in the past few years that are now differentiating Xerox in the marketplace and fueling our growth. We invested heavily in color, determined to be the market leader. We coined the term “The New Business of Printing” and vowed to bring digital technology to what was largely the province of offset or lithographic printing. We also invested in technology and distribution to aggressively attack the office market and expand the business we do with small and mid-size companies. And we vowed to become a services-led partner in large enterprises. I’m not given to exaggeration or hyperbole, but I feel strongly that we have achieved considerable success on all four fronts. Xerox Annual Report 2007 3

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    We’ve made some critical strategic bets in the past few years that are now differentiating Xerox in the marketplace and fueling our growth. Accelerating the adoption of color We’ve led the transition to color from top to bottom across the markets we serve – color that’s both the highest quality and highly affordable. Last year, more than 40 billion pages were printed on Xerox color systems. That’s an increase of 31 percent over 2006 and way ahead of our competitors. In fact, according to estimates by InfoTrends, a leading independent research firm, Xerox accounts for half of the total worldwide color pages printed by high-speed digital systems. And, for us, the power really is in the pages. We operate an annuity-based business with more than 70 percent of our total revenue coming from recurring revenue streams, what we call our “post sale.” This includes interest income from financing our customers’ purchases; service, such as technical support as well as consulting and outsourcing services; and supplies, like ink, paper and toner. The latter is why pages are so important to our business. Post-sale revenue from color pages was up 18 percent year-over-year, so we know the model is working. As that continues to grow, so will Xerox. Color now accounts for about 39 percent of our total revenue, but only 12 percent of our total pages (excluding the benefit of Global Imaging Systems) – indicating a tremendous growth opportunity that we’re well positioned to mine. Last year, we shook up the marketplace by launching an office printer that makes the cost of printing a color page as affordable as black and white. It’s the Phaser® 8860 and it uses our proprietary solid ink, cartridge-free technology, minimizing the impact on the environment. We announced 18 color products in 2007, strengthening what is already the industry’s broadest portfolio of digital color printing systems. Look for more worldclass color technology this year – technology that promises to widen our significant competitive advantage and generates the pages that boost our annuity. 4

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    Last year, more than 40 billion pages were printed on Xerox color systems, an increase of 31 percent and way ahead of competitors. Driving The New Business of Printing® Our leadership in digital high-volume printing complements traditional offset printing. This market transition is The New Business of Printing. The opportunity for digital production printing is about $25 billion, and Xerox’s advantages are the ability to print on demand, produce short runs of books, and customize each and every document that comes off a digital press. In The New Business of Printing, the Xerox iGen3® Digital Production Press continues to be the star performer, but it has a great supporting cast. We’ve now installed more than 2,000 iGen3s around the world. Many customers – 126 to be precise – are printing more than a million pages a month on these market-making marvels. Perhaps the best testimony to their success is that 275 of our customers, many of whom run commercial print shops, have purchased at least two iGen3s and have seen their business soar by offering more digital printing capabilities. At the same time, we’re seeing accelerated demand for the high end of our DocuColor® series and the recently launched Xerox Nuvera® systems. We’re going after the continuous feed market with new technology that redefines the industry standards of speed and quality and gives us a competitive advantage. And we’re partnering with photo imaging companies to use Xerox technology for printing photo applications. In fact, if you order a photo calendar from a retailer that works with Fujifilm, the calendar will be printed on a Xerox press using Xerox paper. As Xerox leads advancements in quality for digital printing, the lines are blurring between the traditional photo imaging business and document processing. InfoTrends predicts the specialty photo printing market – that’s calendars, greeting cards and photo books – will grow at a rate of 24.5 percent per year through 2010, reaching $800 million. Xerox is well on its way to capturing a good share of this growth. Xerox Annual Report 2007 5

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    Net income Post-sale and Color revenue (Millions) financing revenue (Included in total revenue – millions) (Included in total revenue – millions) 1,210 12,475 6,356 1,135 11,451 11,438 11,242 11,182 5,578 978 4,928 859 4,188 3,267 360 ’03 ’04 ’05 ’06 ’07 ’03 ’04 ’05 ’06 ’07 ’03 ’04 ’05 ’06 ’07 Expanding participation in small/medium businesses We also see great opportunity in the office market where we’re investing heavily to win. In 2007, we launched 29 office products that garnered 190 industry awards and broadened and deepened our offerings in this highly competitive market. At the same time, we acquired Global Imaging Systems, which immediately put some 1,400 new sales people on the street and brought more than 200,000 new customers into the Xerox fold. The acquisition has exceeded our expectations and then some. One year ago, this billion-dollar enterprise sold NO Xerox products. By year’s end, 50 percent of the document technology Global Imaging was selling carried the Xerox brand and it is getting better every month. In addition, much of Xerox’s 11 percent growth in developing markets has been fueled by small and mid-size businesses (SMB). We’ve been increasingly building a competitive portfolio of products and services that cater directly to the fast-growing SMB market. We’re making inroads with today’s small businesses that may be tomorrow’s large enterprises. Xerox wants to be with them every step of the way. 6

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    Net cash from Gross margins Selling, administrative operating activities (Percent) and general costs (Millions) (Percent of revenue) 1,879 1,871 42.6 41.6 27.1 26.7 41.2 40.6 40.3 26.2 1,750 25.2 25.0 1,617 1,420 ’03 ’04 ’05 ’06 ’07 ’03 ’04 ’05 ’06 ’07 ’03 ’04 ’05 ’06 ’07 Leading with services Perhaps the greatest transformation has been in our services business, which quietly has become an engine of growth. A few facts make the point. In 2007, the value of services signings was up 18 percent. Services generated $3.4 billion in annuity revenue – up 8 percent over the previous year. Some of the most prestigious enterprises in the world – brands as diverse as United Technologies, HSBC, NASA, EUROPART, The University of California, Raytheon Corp., the United States Navy, and many, many more – are turning to Xerox for help in simplifying work processes, managing their office technology around the world, helping them bridge the paper and digital divide and maximizing their investments in information technology. We’re constantly expanding our service offerings, especially targeting what we call “document-intensive” industries that generate lots of paperwork and digital files. Think health care, where filling out forms for each doctor visit is still the norm. Or, the legal industry, where documentation can make or break cases. All these documents, in any form, need to be managed – scanned, searched, stored and more. And that’s where Xerox’s expertise comes in. Xerox Annual Report 2007 7

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    We like to say that no one knows the document better than Xerox. The ability to manage document-intense processes has opened doors to new business and new markets. And, it’s why we’re investing in acquisitions that further carve out our niche in this space. Last year, we acquired Advectis® Inc. and started Xerox Mortgage Services, which provides one of the mortgage industry’s most widely used solutions for sharing electronic documents. In 2006, we acquired Amici LLC and launched Xerox Litigation Services to become a leading provider of electronic discovery and document services that support legal and regulatory compliance. So just about everywhere you look there are proof points that our strategy is right, our execution focused and our momentum building. That said, Xerox shareholders and the management team share a common belief; as good as our progress has been, it’s now a part of our history. Yesterday’s accomplishments are only important insofar as they provide a bridge to tomorrow’s promise. Growing the business faster Accelerating growth in a competitive environment remains a priority. We’re not yet where we want to be. Key to expanding growth is expanding our distribution channels. It’s the area of improvement where I believe we can make more progress and where we are focusing considerable time, talent and resources. We’re advantaged with a rich portfolio of technology and services, the industry’s smartest experts in document management and a respected brand known around the world. We’re skilled at managing global accounts in big businesses and the commercial print market. But to really ratchet up growth, we need to reach even more potential customers in businesses of any size. Acquiring Global Imaging was a step in the right direction, as was giving our agents and resellers access to more Xerox products and packaged services to sell. We need to – and we will – take this to the next level now by broadening the availability of the Xerox brand through diverse direct and indirect channels. To do this well, we’re connecting even more closely with our customers, predicting and responding to their needs. It’s no secret that I spend a lot of time with customers. So does my entire team. Some of that time is spent fixing problems and some of it selling, but most of it is spent listening – really listening. And when you do that, you learn some pretty interesting stuff. The CEOs I meet with – and they are from a wide variety of industries and geographies – worry that they are not harnessing new technology to leverage growth and better serve their customers. They worry about escalating costs and where to place their IT investment bets so they stay ahead of the curve. They see an explosion of digital information in their enterprises, but are also confronted with a legacy of paper and don’t know how to make sense of it all. They understand the need for information to flow freely and easily throughout their organizations and around the world, but worry about security breaches. 8

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    They’re eager to embrace the promise of a “greener” world, but don’t know how to harness technology to make their infrastructure more sustainable. They are awed by the complexity and potential of technology, but yearn for someone to make it all simpler and more effective. Here’s what excites me. In each of these areas – top-line growth and bottom-line productivity… bridging the digital and paper domains… making document management secure and sustainable… making IT decisions that provide good returns… and making a complex world simple – in all these areas Xerox has answers. Our innovation community is aligned with our strategy and is the best in our industry. Last year, Xerox was awarded 584 U.S. utility patents. Together with our research partner Fuji Xerox, we hold about 8,600 active U.S. patents and continue to invest $1.4 billion a year in research and development. In 2007, we were awarded the National Medal of Technology, America’s highest such honor. It’s a singular accomplishment for Xerox innovators past and present. Our product development community is bringing a steady stream of worldclass technology to market. In the past three years, we have brought more than 100 new products to market. Together with our intelligent software, targeted solutions and tailored services, they bring value to our customers today and assure us continued industry leadership tomorrow. Our distribution channels, already the broadest in our industry, are getting stronger. We have a powerful blend of direct sales people and indirect agents, concessionaires, resellers, dealers and Web-based channels. They have at their disposal a wide array of experts in color, production printing, solutions, software, services and more. Our reach is worldwide, providing a competitive advantage that is unique in our industry. We are on the ground in some 160 countries in every corner of the globe. That becomes increasingly important as our larger customers want help in designing, implementing and maintaining document networks and processes that span the world. Our annuity business model provides a consistent and profitable revenue stream that drives strong cash flow. As I mentioned earlier, more than 70 percent of our revenue comes from post-sale. In 2007, we grew post-sale revenue by 9 percent (6 percent excluding the benefit of Global Imaging*) and added more than $1 billion to our post-sale revenue stream. * See Page 11 for the reconciliation of the difference between this financial measure that is not in compliance with Generally Accepted Accounting Principles (GAAP) and the most directly comparable financial measure calculated in accordance with GAAP. Xerox Annual Report 2007 9

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    And our leadership team is my personal pride and joy. It’s a terrific blend of seasoned Xerox veterans, some great additions from outside the company and some new leaders who have emerged from our own ranks. It’s a team that leads 57,400 Xerox people who consistently deliver on their commitments, have grown earnings in the 10 to 15 percent range, and are determined to do whatever it takes to be successful. It is a team that I am exceptionally proud to lead. Rest assured that we are hardly satisfied with what we have accomplished. We love change and hate the status quo. We embrace challenges and obstacles. We’ve developed a culture that I like to call “problem-curious.” We want to grow faster and win more, not by a little but by a lot. We pride ourselves on listening intently to our customers, connecting with them on a one-to-one basis and committing to finding them the right answer for their unique needs – not some of the time but all of the time. You’ll read more about just that in this report – how we listen, connect and are committed to you. Playing offense with high expectations and great opportunities Our performance in 2008 will be driven by growing our profitable annuity stream – fueled by color and services – and continued discipline in managing costs while generating significant operating cash flow. And, with our strong balance sheet, we’ll focus on share repurchase while being opportunistic in making acquisitions. We do business in a $125 billion market that has attracted a set of competitors we regard with great respect. We know that our customers have choices. We realize that the better we get, the higher our customers’ expectations will get. We are also proud but not content with our record on corporate responsibility. I invite you to read our second Report on Global Citizenship. It’s online at www.xerox.com/citizenship. You will see that we continue to invest in the communities in which we work and live, that our people are active and constructive participants in making our world better, that we have one of the most diverse workforces in the world and that we are a leader but hardly a newcomer in the fight for a sustainable world and a greener planet. This Annual Report to Shareholders is the first to carry our new brand identity, which we launched the first week of 2008. Companies often use new identities in an aspirational way – to signal what they want to become. Our launch is both a statement that we have already arrived at a new place and a promise that our journey continues. I truly believe that our best days are ahead of us. We are playing to our strengths, ushering in a period of great growth for our shareholders, our customers and our people. So, to sum it all up, here’s why I’m confident Xerox will increase value for you: 10

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    We operate a global business with about half of our revenue generated from customers outside of the U.S. From small and medium businesses and the public sector to large enterprises and commercial printers, we serve a wide range of markets – giving us diversification globally and in market scope. We’re an annuity-based business that continues to boost profitable recurring revenues. We’re an investment-grade firm that generates strong cash flow. We’re investing in our business and in our stock. All of us at Xerox are eager to play offense and to give you a good return on your trust. We’re listening, we’re connecting and we’re committed. We know that you, like our customers, have choices. You chose Xerox and we take that very seriously. You can be sure we will do whatever it takes to continue to earn your trust. That’s a promise. Anne M. Mulcahy Chairman and Chief Executive Officer *Non-GAAP Reconciliation Adjusted Earnings Per Share: Full-year ’07 Full-year ’06 (in millions, except per-share data) Net Income Diluted EPS Net Income Diluted EPS As Reported $ 1,135 $ 1.19 $ 1,210 $ 1.22 Adjustments Restructuring and Asset Impairment 254 0.25 Tax Audit Benefits (494) (0.50) Litigation Matters 68 0.07 Credit Facility Fee 9 0.01 Adjusted $ 1,135 $ 1.19 $ 1,047 $ 1.05 Global Imaging Systems Revenue Benefit: Year Ended December 31 (in millions) 2007 2006 %Change Equipment Sales Revenue: As Reported $ 4,753 $ 4,457 7% As Adjusted $ 4,753 $ 4,821 (1%) Post Sale, Financing and Other Revenue: As Reported $ 12,475 $ 11,438 9% As Adjusted $ 12,475 $ 11,812 6% Total Revenue: As Reported $ 17,228 $ 15,895 8% As Adjusted $ 17,228 $ 16,633 4% Revenue “As Adjusted” adds Global Imaging’s results for the period from May 9, 2006, through December 31, 2006, to our 2006 “As Reported” revenue. This calculation excludes the revenue benefit from this acquisition reflected in the 2007 “As Reported” revenue growth. Xerox Annual Report 2007 11

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    What we heard: “For printing and related services, we need to improve efficiency and productivity and build a platform for continuous improvement.” David Smith, Commercial Director U.K. Department for Work and Pensions Xerox Annual Report 2007 13

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    U.K. Department for Work and Pensions What we did: In order to integrate document services across all of DWP’s 1,000+ offices and eliminate redundancies, Xerox assembled a group of leading companies in their fields to simplify a fragmented supply chain. 14

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    How streamlined document services are streamlining the delivery of human services. Listening Connected Committed As the United Kingdom’s largest To improve overall service Besides drawing from its central and civil government delivery, DWP set out to review standard portfolio of document department, the Department and revamp its entire document management services, Xerox for Work and Pensions (DWP) supply chain. It had two principal put in place a dedicated contact delivers services directly to over goals: 1) Make information center and an 80,000-square- 20 million citizens and pays clearer and more easily available foot warehouse so that all out more than $500 million in and accessible to its constituents; document-driven components benefits every year. From “child and 2) Improve efficiency in could be ordered and shipped support” to “welfare to work” keeping with increasingly vigilant from one source. to “pensions management,” it is government reviews. Says David Smith, DWP’s fact that DWP will touch every Implicit in its goals was the Commercial Director, “The citizen in the U.K. at some time need to integrate document approach Xerox and its partners during their lifetime. services across all of its have developed is designed to That amounts to a staggering 1,000+ offices and eliminate ensure that we get real value number of records and the redundancies of work from our partnership and that transactions to manage. performed with multiple suppliers our critical requirements for And with the very well-being in individual departments. print and associated services are of people in the balance, met as and when we need them.” Since it was a tall order for it requires accuracy that any single organization, Xerox With one-third of a nation approaches perfection and assembled iON, a partnership depending on them every day, security that can’t be breached. of leading companies in their DWP was not about to settle fields, to integrate transforma- for anything less. tion across a fragmented supply chain – starting with ordering, through procurement and production, all the way to final delivery to the recipient. Xerox Annual Report 2007 15

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    What we heard: “If you want to communicate something important, put it on a monthly statement.” Håkan Larsson, Technical Director Strålfors Xerox Annual Report 2007 17

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    Strålfors What we did: Strålfors and Xerox worked together to make individualized customer messages come to life in vibrant color and on paper that can be light enough to keep down mailing costs. 18

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    Technology catches up with a great approach to customer care. Listening Connected Committed High-speed, continuous-feed With non-personalized statement Xerox worked closely with color printing. It might not inserts being ignored and tossed Strålfors’ IT, marketing and sound like a warm and fuzzy out routinely, why not embed the sales people to target its most solution to greater customer customized marketing messages likely customers and devise care. But for the high-volume on the statements themselves, specific strategies for each. customers of Strålfors, one of with vibrant, high-impact color? Now throughout Europe, Europe’s preeminent printers Great idea, but no one seemed millions of people receive and managers of information to be doing it without breaking need-to-know and nice-to-know logistics, it is the key to touching the bank, so to speak. That’s information suited specifically many millions of customers, when Strålfors and Xerox for them. Not in predictable, one colorful message at a time. joined forces in applying their institutional black and white, For years, banks, insurance collaborative imagination to but in “cut through the clutter” companies, public utilities and the opportunity at hand. color. The result is much higher telecommunications companies readership and response. Enter the Xerox Color Continuous have recognized that monthly Feed Printing System, with the For Strålfors, what began statements and other necessary power to make individualized many years ago as a great documents are an excellent messages come to life with idea in customer care has opportunity to market to their high-quality color and on paper become an indispensable customers as individuals. that can be light enough to way of doing business. As we heard from Håkan keep down mailing costs. Larsson, Strålfors’ Technical Director, “If you want to communicate something important, put it on a monthly statement because then it will get read.” Xerox Annual Report 2007 19

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    What we heard: “Customers have to validate their paint choices. To do so, they need an accurate printout of what they’ve selected.” Mary Rice, VP, Marketing Behr Xerox Annual Report 2007 21

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    Behr What we did: Xerox Phaser color printers are ® critical links in the process – making sure that what customers choose in the store accurately matches what they want for their home. That step requires true, high-quality printouts of the colors selected. 22

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    Helping do-it-yourselfers validate the right paint color, every time. Listening Connected Committed Embedded in every store of “When it comes to their Xerox provided expertise to The Home Depot® in North surroundings, people don’t Behr in the design of a rugged America (and in parts of Asia), want to make mistakes,” says kiosk cabinet that would keep ColorSmart by BEHR™ kiosks Mary Rice, VP, Marketing, out excessive dust particles and have revolutionized how Paint-Color-Interactive at Behr. would also be easy to reload do-it-yourselfers choose colors “They need to take more than with paper and ink. The cabinet for their painting projects. a paint chip back into the home design helps the printer remain to confirm they’ve made the reliable, no matter how often The interactive color- right choice.” it is used and regardless of the coordination system allows store environment. Without such people to select paint colors In other words, what’s the best a commitment to this critical that complement their samples way to bring a true color to step in the process, the buying of existing paint, fabric and the printed page, so it can decision could be compromised other materials. Then, using be tested at home? For Behr, and the Behr brand impacted. a video monitor to guide the choice was an easy one: the them, they can create a virtual Xerox Phaser® 8500 color printer, Xerox, usually behind the scenes, environment featuring the whose solid-ink technology is specializes in making customers colors they have chosen, and extraordinary in its simulation of look good in the eyes of their experiment with others. the entire range of paint colors. customers. Maybe that’s part of the reason Behr is one of The critical link in the process The added advantage of Xerox’s The Home Depot’s Partners of is validating the customers’ color proprietary solid ink: cartridge- the Year in paint and stain. choices – by providing quality free ink sticks mean less waste color prints they can take home and less space needed to keep as a reference of their selected an ample supply on hand. color schemes. And that’s where Not only does this Xerox Xerox comes in. technology facilitate what is perhaps the most critical element in the buying process, it does so in a challenging environment. Not the refined confines of an office, but the robust, let’s-get-it-done arena of home improvement. Behr needed a partner that understood the difference and could deliver the required quality, again and again. Xerox Annual Report 2007 23

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    What we heard: “Packaging is as much our product as what our customers put in their gardens or in their living rooms. It’s got to be top-flight.” Stefan Yauchzee, General Manager Potting Shed Creations, Ltd.TM Xerox Annual Report 2007 25

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    Potting Shed Creations, Ltd. ™ What we did: Developed affordable, easy-to-use color technology that delivers the quality, reliability and speed small businesses need to showcase their company. 26

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    Helping to grow a growing business. Listening Connected Committed Potting Shed Creations’ business People tend to think of Xerox Potting Shed Creations chose is growing, in many more ways when they think of large Xerox color laser printers to get than one. Gardeners, interior companies. True enough. But the job done. The reliable Xerox decorators, landscape designers we also bring all that is Xerox technology adds the speed, and gift-givers have come to rely to businesses that are modest adaptability and affordability on the company for an array of in size but thinking big. that a nimble, fast-paced small organic bulbs, plants and seeds. business needs. Potting Shed Creations is a From a converted school perfect example. Since packaging The result for Potting Shed in Idaho’s panhandle, is such an integral part of their Creations has been profitable the business has gone global success, they recognized that growth today with plenty of through specialty distributors their labels – works of art in room to grow in the future. With and selling online at themselves – needed vibrant the industry’s broadest portfolio www.pottingshedcreations.com. color, but at a cost the company of color technology, we’re in a could afford. unique position to do the same One of its main reasons for for any business of any size. success? Packaging. Imaginative, With orders for one of their decorative, enticing, eco-friendly products running from just packaging. Who can resist the a few to many hundreds at seeds for a scatter garden when any given time, they also they come adorned with birds, needed flexibility that only butterflies and bows? an easy-to-use office printer can provide. That meant the The question to us was how ability to print labels, brochures Xerox technology could make and other materials that are their continued growth just high in quality and low in cost. as irresistible. Xerox Annual Report 2007 27

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    Board of directors 8 10 2 4 6 A: Member of the Audit Committee 7 9 1 3 5 B: Member of the Compensation Committee C: Member of the Corporate Governance Committee D: Member of the Finance Committee 1. Anne M. Mulcahy 7. Mary Agnes Wilderotter D Chairman and Chief Executive Officer Chairman, Chief Executive Officer and President Xerox Corporation Citizens Communications Norwalk, CT Stamford, CT 2. Ursula M. Burns 8. Vernon E. Jordan, Jr. B, C President Senior Managing Director Xerox Corporation Lazard Frères & Co., LLC Norwalk, CT New York, NY 3. N. J. Nicholas, Jr.B, D Of Counsel, Akin, Gump, Strauss, Investor Hauer & Feld, LLP New York, NY Washington, DC 4. William Curt Hunter A, C 9. Glenn A. Britt A, D Dean, Tippie College of Business President and Chief Executive Officer University of Iowa Time Warner Cable Iowa City, IA Stamford, CT 5. Ann N. Reese C, D 10. Ralph S. Larsen B, C * Executive Director Former Chairman and Chief Executive Officer Center for Adoption Policy Studies Johnson & Johnson Rye, NY New Brunswick, NJ 6. Robert A. McDonald A, B Richard J. Harrington A (not pictured) Chief Operating Officer President and Chief Executive Officer The Procter & Gamble Company The Thomson Corporation Cincinnati, OH Stamford, CT * Mr. Larsen is not standing for reelection at the 2008 Annual Meeting of Shareholders 28

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    30 Our business 52 Management’s Discussion and Analysis of Results of Operations and Financial Condition 77 Consolidated Statements of Income 78 Consolidated Balance Sheets 79 Consolidated Statements of Cash Flows 80 Consolidated Statements of Common Shareholder’s Equity 81 Notes to the Consolidated Financial Statements 132 Reports of Management 133 Report of Independent Registered Public Accounting Firm 134 Quarterly Results of Operations (Unaudited) 135 Five Years in Review 136 Corporate information Xerox Annual Report 2007 29

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    Our business We are a $17.2 billion technology and services enterprise and a leader in the global document market. We develop, manufacture, market, service and finance a complete range of document equipment, software, solutions and services. Overview References in this section to “we,” “us,” “our,” the “Company” and “Xerox” refer to Xerox Corporation and its subsidiaries unless the context specifically states or implies otherwise. The document industry is transitioning to digital systems, to color, and to an increased reliance on electronic documents. More and more, businesses are creating and storing documents digitally and using the Internet to exchange electronic documents. We believe these trends play to the strengths of our product and service offerings and represent opportunities for future growth in the $125 billion market we serve. In our core markets of Production and Office, we are well-positioned to lead in this large and growing market through our four growth planks: • Accelerate the adoption of color • Lead with services in large enterprises • Drive the New Business of Printing® • Expand participation in small/mid-size business market 30

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    We serve a $125 billion market (in billions) ■ $76 Office We are well positioned to capture growth by leading the transition to color and by reaching new customers with our broad offerings and expanded distribution channels. ■ $24 Services Our value-added services deliver solutions that not only optimize enterprise output spend and infrastructure, but also streamline, simplify and digitize our customers’ document-intensive business processes. ■ $17 Eligible offset We are creating new market opportunities in targeted application areas with digital printing as a complement to traditional offset printing. ■ $8 Production We are the only provider in the market that offers a complete family of monochrome This estimate, and the market estimates that follow, is and color production systems, business calculated by leveraging third-party forecasts from firms development tools and workflow solutions. such as International Data Corporation and InfoSource in conjunction with our assumptions about our markets. Color is the fastest growing portion of our market, and we estimate that it represents $27 billion of the market opportunity. Economic and quality improvements in color are driving the market transition to color. We have the broadest color portfolio in the industry and our leading technologies, such as solid ink, position us well to participate in this transition and accelerate the adoption of color. At the same time, we continue to compete to capture growth opportunities within the black-and-white segment of our core markets, which we estimate is a $58 billion market. We are growing our core markets by leading with document management services (also referred to as Xerox Global Services), which is the combination of managed services and value-added services. We have organized our document management services around three offerings: 1) Xerox Office Services, where we help our customers reduce costs and improve productivity by optimizing their global print infrastructure through analyzing the most efficient ways to create and share documents in the office; 2) Document Outsourcing and Communication Services, which focuses on optimizing the production environment as well as operating in-house production centers; and 3) Business Process Services, where we show our customers how to use digital workflow to re-engineer their business processes and develop online document repositories. Xerox Annual Report 2007 31

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    Our business We are creating new market opportunities with digital printing as a complement to traditional offset printing through a market transition we call “The New Business of Printing”. We are driving the New Business of Printing opportunity by identifying applications which are suitable for digital production and represent what we refer to as the “eligible offset” market. With our leading business development tools, workflow and digital technology, led by our market-making Xerox iGen3® technology, we are uniquely positioned to meet the increasing demand for short-run, customized and quick-turnaround offset quality printing. Over the past year we have scaled up our presence in the small and mid-size business (SMB) market, most notably through our acquisition of Global Imaging Systems, Inc. (GIS). This increased distribution capacity, along with a strong product portfolio in this segment, is expanding our participation in SMB and opening up new growth opportunities. Our products include high-end printing and publishing systems; digital multifunctional devices (MFDs) which can print, copy, scan and fax; digital copiers; laser and solid ink printers; fax machines; document-management software; and supplies such as toner, paper and ink. We provide software and workflow solutions with which businesses can easily and affordably print books, create personalized documents for their customers, and scan and route digital information. Our business model is an annuity model where post sale and financing revenue growth is driven by increasing equipment installations which increases the number of page producing machines in the field (MIF) and expanding the document management services we offer our customers. 72% of our 2007 total revenue was post sale and financing revenue that includes equipment maintenance and consumable supplies, among other elements. We sell the majority of our equipment through sales-type leases that we record as equipment sale revenue. Equipment sales represented 28% of our 2007 total revenue. 32

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    Revenue stream ■ 28% Approximately 28% of our revenue comes from equipment sales, from either lease arrangements that qualify as sales for accounting purposes or outright cash sales. ■ 72% The remaining 72% of our revenue, “Post sale and financing,” includes annuity-based revenue from maintenance, services, supplies and financing, as well as revenue from rentals and operating lease arrangements. The number of equipment installations is a key indicator of post sale and financing revenue trends as is the growth in document management services. The mix of color pages is another significant indicator of post sale revenue trends because color pages use more consumables per page than black-and-white. In addition, expanding our market, particularly within the eligible offset market, is key to increasing pages and we have leading tools and resources to develop this large market opportunity. Xerox Annual Report 2007 33

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    Our business We made two acquisitions in 2007: A provider of office technology for small and mid-size businesses in the U.S. and a provider of a web-based solution to electronically manage mortgage loan documents. Acquisitions To further our business goals, in 2007 we completed the acquisitions of GIS, a provider of office technology for small and mid-size businesses in the United States, and Advectis®, Inc. (Advectis), a provider of a web-based solution that electronically manages the process to underwrite, audit, collaborate, deliver and archive mortgage loan documents. GIS focuses on the SMB market through 22 regional core companies in the U.S. that sell and service document management systems. With the GIS acquisition, we increased our distribution capacity in the SMB market in the U.S. by approximately 50%, where the total opportunity for document-related offerings is estimated at $16 billion. GIS currently serves about 200,000 customers with about 1,400 sales representatives and 1,700 service technicians. Since acquiring GIS, they acquired four additional companies in 2007, further expanding our distribution. In addition, as of the fourth quarter of 2007, roughly half of GIS equipment available for sale was Xerox equipment compared to none a year ago. Advectis’ web-based BlitzDocs Collaboration Suite helps users reduce costs associated with the lending process, deliver better services, decrease credit risk and build a competitive advantage in capturing new loan applications. Advectis, now branded Xerox Mortgage Services, similar to our acquisition last year of Amici, expands our business process services capabilities into yet another vertical document intensive area. 34

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    Reviews by business segment (in millions) ■ $8,304 Office Our Office segment serves global, national and small to mid-size commercial customers as well as government, education and other public sector customers. ■ $4,771 Production Our Production segment provides high-end digital monochrome and color systems designed for customers in the graphic communications industry and for large enterprises. ■ $2,155 DMO DMO includes the marketing, sales, and servicing of Xerox products, supplies, and services in Latin America, Brazil, the Middle East, India, Eurasia and Central-Eastern Europe, and Africa. ■ $1,998 Other The Other segment includes revenue primarily from paper sales, wide-format systems, value-added services and Global Imaging Systems network integration solutions and electronic presentation systems. Segment information Our reportable segments are Production, Office, Developing Markets Operations (DMO), and Other. We present operating segment financial information in Note 2-Segment Reporting in the Consolidated Financial Statements, which we incorporate by reference here. We have a very broad and diverse base of customers, both geographically and demographically, ranging from SMB to graphic communications companies, governmental entities, educational institutions and large (Fortune 1,000) corporate accounts. None of our business segments depends upon a single customer, or a few customers, the loss of which would have a material adverse effect on our business. Beginning in 2008, we will not report DMO results in a separate segment, but will include their results within our Office, Production and Other segments. More details on this change are included on page 68 within the Segment Reporting Change section of the Management Discussion and Analysis in our 2007 Annual Report. Xerox Annual Report 2007 35

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    Our business Production We provide high-end digital monochrome and color systems designed for customers in the graphic communications industry and for large enterprises. These high-end devices enable digital on-demand printing, digital full-color printing, and enterprise printing. We are the only manufacturer in the market that offers a complete family of cut sheet monochrome production systems from 65 to 288 pages per minute (ppm), color production systems from 40 to 110 ppm, and a complete line of continuous feed printers from 250 to 1,064 ppm. In addition, we offer a variety of pre-press and post-press options and the industry’s broadest set of workflow software. With our Freeflow™ digital workflow collection, our customers can improve all aspects of their processes, from content creation and management to production and fulfillment. Our digital technology, combined with total document solutions and services that enable personalization and printing on demand, delivers value that improves our customers’ business results. Our 2007 Production goals Our 2007 goals for our Production segment were to continue strengthening our leadership position in monochrome and color and to build on the power of digital printing in the eligible offset market. Our “New Business of Printing” strategy complements the traditional offset market and continues to transform our industry. We are enabling print providers in graphic communications and large enterprises to profit and grow by meeting their customers’ specific business needs with just-in-time, one-to-one and e-based services – rather than simply manufacturing a printed piece. Having the right business model, the right workflow, and the right technology are fundamental to this transformation. In 2007 we launched an application-focused program to assist our customers implement solutions in four major categories. The “Can Do” program provides our customers live end-to-end applications for: Collaterals by Request, Books, Transactional/Promotional and Direct Mail. We continued to increase installations of our flagship Digital Color Production Presses. In April 2007, according to estimates by InfoTrends, a leading independent research firm, Xerox’s installed base of DocuColor and iGen3 presses accounted for approximately 50 percent of the total worldwide page volume printed by high speed production color printers. We are the industry leader in the number of pages produced on digital production color presses, with our flagship Xerox iGen3 Digital Production Press and DocuColor® Digital Presses. In 2007, we continued to build on our unmatched product breadth, world class market and business development tools and integrated end-to-end applications. Below are some of the key accomplishments that enabled us to reach our goals: 36

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    Our 2007 Production accomplishments Right business model • ProfitAccelerator™ – this robust set of tools and programs designed to maximize our customer’s investment in digital printing equipment expanded in 2007 to now include more than 75 tools. It brings together Xerox’s unparalleled experience and expertise, world-class resources and industry-leading support. Some of the newest additions include an audio sales training course, a kit to assist customers pursuing the digital book opportunity, and a new financial modeling tool that will increase productivity and achieve cost and efficiency savings. • New Business of Printing Services – Business Development Services were built in response to customer requirements and will provide both training and professional services to help print providers increase page volume and revenue. The three initial services offerings are developing a digital marketing plan, selling one-to-one marketing campaigns and web-to-print jobs, and training and managing a digital sales force. The offerings are executed by a dedicated team of Xerox business development consultants and industry experts. Right workflow With our Freeflow™ digital workflow collection our customers can improve efficiency for everything from content creation and management to production and fulfillment. In 2007 the FreeFlow suite of workflow software was enhanced to uniquely enable our customers to connect with print users 24 hours a day, 7 days a week, reduce costs, and enable new applications and revenue streams. A few highlights include: • Xerox FreeFlow Process Manager 6.0 – software that provides automated, “touchless” file preparation and decision making to automate prepress and eliminate manual production steps. • Xerox FreeFlow Variable Information Suite 6.0 – software that delivers the maximum productivity for personalized and customized documents. The software also now supports award winning specialty effects that help print providers minimize document security concerns while enabling new applications. These effects include MicroText marks, Correlation Marks, Glossmark®, FlorescentMark, and InfraRed text. • FreeFlow Print Server – a newly launched, powerful print server that delivers superior performance, advanced workflow interoperability, state-of-the-art color management, and a common workflow for Xerox production printers. Xerox Annual Report 2007 37

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    Our business Right technology • Xerox DocuColor 8000AP and Xerox DocuColor 7000AP – In May and September we launched 80 ppm and 70 ppm full-color production systems, respectively, which provide excellent print resolution, color reproduction and reliability for a wide range of application and weights, all at rated speed. • Xerox DocuColor 260 – We expanded our full color offerings with the launch of the DocuColor 260 in September, a 60 ppm light production printer. The combination of quality, reliability and price point makes it easy to get started in digital full color printing. • Xerox 490/980 Color Continuous Feed Printing System – We announced the world’s fastest toner based full color roll fed printer that produces up to 986 full color duplex images per minute. This system is ideal for the Transactional/Promotional and Direct Mail market segments that require high speed, high volume variable data printing. • Xerox 495 Continuous Feed Duplex Printer – We expanded our offerings within the Continuous Feed market with the February launch of a 500 ppm continuous feed duplex printer with two imaging systems built into one device, flash fusing and a small footprint ideal for high quality, high volume duplex applications. • Xerox Nuvera® 288 Digital Perfecting System – Launched in April, this is the fastest cut sheet monochrome duplex printer in the market. This system, with its benchmark image quality, flexibility of substrates and reliability, enables applications such as book publishing. • Xerox Nuvera 100/120/144 EA Digital Production Systems – A new family of Xerox Nuvera digital production systems was launched in April, utilizing Emulsion Aggregate (EA) toner for greater reliability and image quality. This modular, scalable print engine also expands digital printing applications due to its high quality and flexibility of substrates. • Xerox DocuTech® Highlight Color 128 and 155 Publishing System – In April, we expanded our highlight color publishing system family for print on demand. These systems print both black and white, as well as highlight color at rated speeds of 128 and 155 ppm, respectively. • Xerox 4595 CP and 4110 CP with DocuSP – In April, we continued to expand our presence in the light production segment with the launch of the Xerox 4595 CP and 4110 CP with DocuSP. These digital light production systems at 95 ppm and 110 ppm feature high quality, easy to use systems that offer production workflow software that can make them part of an Enterprise distributed print solution. • Xerox 4112/4127 – In September, we introduced our latest light production monochrome printers. The 4112 and 4127 include upgrades in speed, up to 125 ppm, enhanced application capabilities and substrate handling. Both products were launched with FreeFlow PrintServer. • Custom Blended Color Program for DocuTech Highlight Color Systems – In 2007, we expanded the range of colors to over 80 custom colors, enabling our customers to match company logos for brand identity applications. 38

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    Office Our Office segment serves global, national, and small to mid-size commercial customers as well as government, education and other public sector customers. Office systems and services, which include monochrome devices at speeds up to 95 ppm and color devices up to 60 ppm, include our family of CopyCentre®, WorkCentre® and WorkCentre® Pro digital multifunction systems, Phaser™ desktop printers and MFD’s as well as DocuColor printer/ copiers for the specific needs of graphic intensive organizations and facsimile products. We offer a complete range of solutions in partnership with independent software vendors that allow our customers to analyze, streamline, automate, secure and track their digital workflows, which we then use to identify the most efficient, productive mix of office equipment and software for that business, helping to reduce the customer’s document-related costs. Our 2007 Office goals Our 2007 Office goals were to drive the transition to color in the office, to extend our market reach, particularly in the SMB market, and to continue to expand our Office Services business. We aimed to broaden our product line and complement our industry-leading product offerings with expanded distribution to increase our machines-in-field (MIF) and capture more pages, building the foundation for future post sale revenue growth. We continued to drive color in our Office segment by significantly enhancing our already strong color product portfolio, making color more affordable, easier to use, faster and more reliable. The breadth of our color product portfolio is unmatched. Our color-capable laser devices provide an attractive color entry point, our patented solid ink technology offers unmatched ease of use, vibrant color image quality and economic color run costs, and our top of the line color laser products provide superior image quality coupled with industry-leading productivity and reliability. Below are some of the key accomplishments that enabled us to achieve our goals: Our 2007 Office accomplishments • Phaser 8560 – With the February introduction of the 8560, we continued to leverage our patented solid ink technology to provide offices with affordable, easy to use color. The 8560 can print at speeds up to 30 ppm in color and black-and-white and is offered in both standalone printer and multifunction configurations. • Phaser 6180 – In February, we strengthened our color laser offerings with the introduction of the Phaser 6180. The 6180 prints at speeds up to 20 color ppm and 26 ppm in black-and-white and utilizes Xerox’s environmentally friendly EA toner. The 6180 is offered in both standalone printer and multifunction configurations. • Phaser 6360 – In February, we introduced the Phaser 6360. With speeds up to 42 ppm in color and black-and-white, the 6360 is the world’s fastest letter-size color laser printer. • WorkCentre 7328/7335/7345 – In April, we introduced the WorkCentre 7300 product family. These devices print and copy at speeds ranging from 26 to 35 ppm color and 28 to 45 ppm black-and-white. The systems also scan and fax, and include new tools to integrate and improve workflows and manage color costs. Xerox Annual Report 2007 39

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    Our business • DocuColor 260 – Introduced in April, the DocuColor 260 Digital Color Printer/Copier is the fastest color system in the Xerox office line, printing and copying at up to 60 ppm in color and 75 ppm in black-and-white. It features the EFI® Fiery® embedded controller, which enables customers to easily program, monitor and manage workflow. As a result, the DocuColor 260 brings outstanding image quality and productivity to offices and departments that want to create their own high-end materials without having to invest in a full production press. • WorkCentre 7232/7242 – In September, we continued to bring affordable color to the office with the WorkCentre 7232 and 7242 color-capable multi-function products. The 7232 is capable of printing 10 ppm color and 32 ppm black-and-white, while the 7242 increases the black-and-white productivity to 40 ppm. • WorkCentre 7675 – In September, we introduced the WorkCentre 7675, offering color pages at 50 ppm and black-and-white pages at 75 ppm. The 7675 provides superior image quality, excellent productivity, extensive media handling and professional in-line finishing capabilities. • Phaser 8860 – Launched in September, this is the first printer to feature the next generation of Xerox’s solid ink technology, enabling us to bring affordable color to offices of any size. The new solid ink dramatically lowers the cost of color prints enabling Xerox to offer innovative pricing, giving our customers ‘color for the price of black-and- white’. The 8860 operates at print speeds as fast as 30 ppm in color and black-and-white and is offered in both standalone printer and multifunction configurations. We completely refreshed the core of our black-and-white multifunction series, further strengthening our position. • WorkCentre 5632/5638/5645/5655/5665/5675 – Introduced in August, the 5600 product family refreshed the entire black-and-white multifunction product line in the Segments 3–5 market. • Xerox 4595 Digital Copier/Printer – Introduced in April, the 4595 is a high-volume, black-and-white copier/printer to meet the continuing need for high volume monochrome office printing. With scanning speeds up to 100 ppm and print and copy speeds up to 95 ppm, this system is a true workhorse for high-volume environments such as office workgroups, and educational and financial institutions. The Xerox 4595 is also available with the light-production finisher for a full range of output choices. • Extensible Interface Platform – Announced in October 2006, Xerox’s Extensible Interface Platform (EIP) is a software platform developers can use to create server-based applications for multifunction devices and that can be configured for the MFD’s touch- screen user interface. Using this interface, workers can enter a password or use a secure smart card at the MFD and access a set of features and options designed specifically for their business needs. A wide range of document management and workflow software has already been developed by Xerox and its Alliance Partners to help organizations manage costs, boost productivity and improve efficiency. In 2007, Xerox expanded the worldwide implementation of this platform including it on all major workgroup and departmental MFD introductions. 40

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    DMO DMO includes the marketing, sales and servicing of Xerox products, supplies, and services in Latin America, Brazil, the Middle East, India, Eurasia and Central-Eastern Europe and Africa. In countries with developing economies, DMO manages the Xerox business through operating companies, subsidiaries, joint ventures, product distributors, affiliates, concessionaires, value-added resellers and dealers. Our two-tiered distribution model has proven very successful in the high-growth geographies of Russia and Central- Eastern Europe. Our 2007 DMO goals included revenue growth, a continued focus on improving the entire cost base and providing a foundation for profitable growth. Other The Other segment primarily includes revenue from paper sales, value-added services, wide-format systems and GIS network integration solutions and electronic presentation systems. We sell cut-sheet paper to our customers for use in their document processing products. The market for cut-sheet paper is highly competitive and revenues are significantly affected by pricing. Our strategy is to charge a premium over mill wholesale prices, which is adequate to cover our costs and the value we add as a distributor, as well as to provide unique products that enhance the “New Business of Printing” and color output. An increasingly important part of our offering is value-added services, which uses our document industry knowledge and experience. Our value-added services deliver solutions that optimize our customers’ document output and infrastructure costs while streamlining, simplifying, and digitizing their document-intensive business processes. In October 2007, we acquired Advectis, a provider of a web-based solution that electronically manages the process to underwrite, audit, collaborate, deliver and archive mortgage loan documents. In July 2006 we acquired Amici, a provider of web-based electronic discovery (E-discovery) services, primarily supporting litigation and regulatory compliance. Often our value-added services solutions lead to larger managed services contracts which include our equipment, supplies, service, and labor. We report the revenue from managed services contracts in the Production, Office, or DMO segments. In 2007, the combined value-added services and managed services revenue, including equipment, totaled $3.8 billion. In our wide-format systems business, we offer document processing products and devices designed to reproduce large engineering and architectural drawings up to three feet by four feet in size. Xerox Annual Report 2007 41

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    Our business Revenues by geography (in millions) ■ $9,078 U.S. ■ $5,888 Europe ■ $2,262 Other areas Revenues by geography based on the location of the unit reporting the revenue and includes export sales. About 50% of our revenue is generated from customers outside the U.S. Revenue We sell the majority of our products and services under bundled lease arrangements, in which our customers pay a monthly amount for the equipment, maintenance, services, supplies and financing over the course of the lease agreement. These arrangements are beneficial to our customers and us since, in addition to customers receiving a bundled offering, these arrangements allow us to maintain the customer relationship for future sales of equipment and services. We analyze these arrangements to determine whether the equipment component meets certain accounting requirements such that the equipment fair value should be recorded as a sale at lease inception, that is, a sales-type lease. We allocate the remaining portion of the monthly minimum payments to the various elements of the lease based on fair value – service, maintenance, supplies and financing – that we generally recognize over the term of the lease agreement, and that we report as “post sale and other revenue” and “finance income” revenue. In those arrangements that do not qualify as sales-type leases, which have increased as a result of our services-led strategy, we recognize the entire monthly payment over the term of the lease agreement, whether rental or operating lease, and report it in “post sale and other revenue.” Our accounting policies for revenue recognition for leases and bundled arrangements are included in Note 1-Summary of Significant Accounting Policies in the Consolidated Financial Statements in our 2007 Annual Report. 42

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    R,D&E expenses (in millions) $922 $943 $912 $148 $161 $188 $764 $761 $755 ■ R&D ■ Sustaining engineering ’07 ’06 ’05 Research and development Investment in R&D is critical for competitiveness in Xerox’s fast-paced markets where more than two-thirds of our equipment sales are from products launched during the past two years. Xerox’s R&D drives innovation and customer value by: • Creating new differentiated products and services. • Enabling cost competitiveness through disruptive products and services. • Enabling new ways to serve customers. • Creating new business opportunities to drive future growth by reaching new customers. Xerox Annual Report 2007 43

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    Our business Our R&D is strategically coordinated with that of Fuji Xerox, which invested $672 million in R&D in 2007, $660 million in 2006 and $720 million in 2005. To ensure our success, we have aligned our R&D investment portfolio with our strategic planks: accelerating the color transition, driving the “New Business of Printing®”, enhancing customer value by leading with services and expanding our participation in the SMB market. 2007 R&D spending focused primarily on the development of high- end business applications to drive the “New Business of Printing®”, extending our color capabilities, expanding our services offerings and delivering lower-cost platforms and customer productivity enablers. The Xerox iGen3, an advanced next-generation digital printing press that produces photographic-quality prints indistinguishable from offset, the Xerox Nuvera 288 Digital Perfecting System that boasts the fastest (288 duplex impressions per minute) digital duplex monochrome cut-sheet printer in the industry and Xerox’s proprietary Solid Ink technology for the office are examples of the type of breakthrough technology we developed and that we expect will drive future growth. Sustaining engineering expenses, which are the hardware engineering and software development costs we incur after we launch a product are included in our R,D&E expenses. We are incorporating by reference the amounts spent for research, development and engineering for 2007, 2006 and 2005 that are included in Note 1-Summary of Significant Accounting Policies in the Consolidated Financial Statements in our 2007 Annual Report. 44

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    Patents, trademarks and licenses We are a technology company. Including our Xerox Palo Alto Research Center (PARC) subsidiary, we were awarded 584 U.S. utility patents in 2007. We were ranked 33rd on the list of companies that were awarded the most U.S. patents during the year and would have been ranked 27th with the inclusion of PARC patents. Including our research partner, Fuji Xerox Co., Limited, we were awarded over 900 U.S. utility patents in 2007. Our patent portfolio evolves as new patents are awarded to us and as older patents expire. As of December 31, 2007, we held approximately 8,600 design and utility U.S. patents. These patents expire at various dates up to 20 years or more from their original filing dates. While we believe that our portfolio of patents and applications has value, in general no single patent is essential to our business or any individual segment. In addition, any of our proprietary rights could be challenged, invalidated, or circumvented or may not provide significant competitive advantages. In the U.S., we are party to numerous patent-licensing agreements and, in a majority of them, we license or assign our patents to others, in return for revenue and/or access to their patents. Most of the patent licenses expire concurrently with the expiration of the last patent identified in the license. In 2007, including our PARC subsidiary, we added 9 agreements to our portfolio of patent licensing agreements, and either we or our PARC subsidiary was a licensor in 7 of the agreements. We also have a number of cross-licensing agreements with companies with substantial patent portfolios, including Canon, Microsoft, IBM, Hewlett Packard, Océ and Sharp. Those agreements vary in subject matter, scope, compensation, significance and time. In the U.S., we own approximately 550 trademarks, either registered or applied for. These trademarks have a perpetual life, subject to renewal every ten years. We vigorously enforce and protect our trademarks. Competition Although we encounter aggressive competition in all areas of our business, we are the leader or among the leaders in each of our principal business segments. Our competitors range from large international companies to relatively small firms. We compete primarily on the basis of technology, performance, price, quality, reliability, brand, distribution, and customer service and support. To remain competitive we invest in and develop new products and services and continually improve our existing offerings. Our key competitors include Canon, Ricoh, IKON, Hewlett-Packard, and, in certain areas of the business, Pitney Bowes, Kodak, Océ, Konica-Minolta and Lexmark. We believe that our brand recognition, reputation for document knowledge and expertise, innovative technology, breadth of product offerings, global distribution channels, customer relationships and large customer base are important competitive advantages. We and our competitors continue to develop and market new and innovative products at competitive prices, and, at any given time, we may set new market standards for quality, speed and function. Xerox Annual Report 2007 45

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    Our business We operate in more than 160 countries worldwide. Xerox develops, manufactures, markets and supports document management systems, supplies, and services through a variety of distribution channels around the world. ■ Xerox North America Xerox North America operates across the United States and Canada. ■ DMO Developing Markets Operations supports more than 130 countries. ■ Xerox Europe Xerox Europe covers 17 countries across Europe. ■ Fuji Xerox Fuji Xerox, an unconsolidated entity of which we own 25%, develops, manufactures, and distributes document management systems, supplies and services. The Xerox brand is a valuable resource and continues to be recognized in the top ten percent of all U.S. brands. Marketing and distribution We manage our business based on the principal business segments described earlier. However, we have organized the marketing and selling of our products and solutions according to geography and channel types. We sell our products and solutions directly to customers through our worldwide sales force and through a network of independent agents, dealers, value-added resellers and systems integrators. We use our direct sales force to address our customers’ more advanced technology, solutions and services requirements, and use cost-effective indirect distribution channels for basic product offerings. 46

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    In large enterprises, we follow a services led approach that allows us to address two basic challenges facing large enterprises: 1) How to optimize their infrastructure to be both cost effective and globally consistent. 2) How to improve their value proposition and communication with their customers. In response to these needs, we bring a go-to-market approach that leads with the largest direct sales and service delivery force in the industry available on a globally consistent manner. This can range from hardware, software or services in whatever combination is necessary to meet the needs of that customer. In 2007 we substantially increased our distribution capabilities to the SMB market in the U.S. through our acquisition of GIS. GIS has a proven track record of delivering value to customers in the SMB market through a decentralized management structure that emphasizes local customer connections and empowerments. We have maintained that operating structure and approach. GIS, which had previously not distributed Xerox products, now brings Xerox product options to a segment of the market where we were previously underrepresented. GIS was built up over the years through acquisitions and now operates in 32 states in the U.S. In 2007 GIS acquired six additional companies, four after our acquisition of GIS, and going forward we will continue to support GIS in expanding its footprint. Xerox Annual Report 2007 47

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    Our business We market our Phaser line of color and monochrome laser-class and solid ink printers primarily through office information technology industry resellers, who typically access our products through distributors. In 2007, we expanded our distribution partnerships in North America by recruiting an expanded set of information technology resellers and enhancing our network of independent agents. We also continued to increase the product offerings available through a two-tiered distribution model in Europe and DMO. We are increasing our use of partners to expand our market coverage. Through reseller alliances with Fujifilm Graphics Systems and Fujifilm Imaging Systems, we distribute our production products to graphic communications customers and the photo market industries. In 2007 we signed a contract with Fujifilm Graphics Systems in Europe to compliment the contracts in the U.S. and Canada. We have launched in six western European countries and will continue to expand throughout 2008. We also signed a reseller contract with Fujifilm Imaging Systems in both the U.S. and Canada to enable a channel for production products that support the digital photo specialty application market. We also have an alliance with Electronic Data Systems (EDS) which is designed to integrate EDS’ information technology (IT) services with our document management systems and services to provide customers with full IT infrastructure support. Overall, through The Xerox Connection partner program, we have over 125 partners who work with us to provide solutions. In Europe, Africa, the Middle East, India, and parts of Asia, we distribute our products through Xerox Limited, a company established under the laws of England, and related non-U.S. companies all of which we refer to as Xerox Limited. Xerox Limited enters into distribution agreements with unaffiliated third parties covering distribution of our products in some of the countries located in these regions, and previously entered into agreements with unaffiliated third parties covering distribution of our products in Iran, Sudan, and Syria. Iran, Sudan, and Syria, among others, have been designated as state sponsors of terrorism by the U.S. Department of State and are subject to U.S. economic sanctions. We maintain an export and sanctions compliance program and believe that we have been and are in compliance with U.S. laws and government regulations for these countries. In addition, we had no assets, liabilities, or operations in these countries other than liabilities under the distribution agreements. After observing required prior notice periods, Xerox Limited terminated its distribution agreements related to Sudan and Syria in August 2006 and terminated its distribution agreement related to Iran in December 2006, and now has only legacy obligations such as providing spare parts and supplies to these third parties. In 2007, we had total revenues of $17.2 billion, of which approxi- mately $7.7 million was attributable to Iran and less than $0.25 million in total was attributable to Sudan and Syria. As a result of the termination of these agreements, we anticipate that our revenues attributable to these countries will decline. In January 2006, Xerox Limited entered into a five-year distribution agreement with an unaffiliated third party covering distribution of our products in Libya. Libya is also designated as a state sponsor of terrorism by the U.S. Department of State. The decision to enter into this distribution agreement was made in light of recent U.S. federal govern- ment actions that have lifted the countrywide embargo previously imposed on Libya. Our sales in Libya through this distribution agreement will be subject to our export and sanctions compliance program and will be according to the U.S. laws and government regulations that relate to Libya. 48

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